Robin Fox, President of Kleinwort Benson Asia, has watched a lone China open up for business to the world. Here he comments on the impact of developing international relationships in the world of finance
As someone who has visited China for a number of years, you must have seen a lot of changes in the country, particularly in the world of finance. How has this affected the way in which foreigners approach the market?
I have been visiting China for 20 years, with my first visit coming shortly after the death of Mao and the arrest of the Gang of Four. It is sometimes difficult to remember how different things were in those days. For example, you never knew your programme in advance and it was unusual to meet the same people on consecutive visits as it was felt that they might get too close to you. On a financial level it was difficult to arrange and finance projects because no Chinese entity was allowed to borrow from a foreign bank. However, we developed a way round that restriction by introducing Deposit Facilities whereby a foreign bank was allowed to deposit foreign currency with the Bank of China, and the Bank of China in turn financed the project. It sounds easy now but at the time it involved considerable acrobatics to end up with the right solution, politically correct to Chinese eyes but still benefiting from the protective guarantee and subsidised interest rates of the United Kingdom Export Credits Guarantee Department (ECGD).
Of course matters have moved on since then, and buyer credits in various currencies have become commonplace, but I think a notable milestone on the road came in 1987 with the negotiation by Kleinwort Benson of the first 'soft loan' from the United Kingdom to China. The same year the first Chinese bond issue in modern times was launched on the London market, a Floating Rate Note by the Bank of China. Now Chinese institutions have become some of the most sophisticated borrowers in the world.
They may be sophisticated borrowers, but is the rest of the world ready to lend them the large sums of money that are required for the development of the economy?
I agree that enormous sums are required, especially for the infrastructure which badly needs to be built up. There is a requirement for transport facilities such as roads, railways, bridges, ports and airports, also energy related projects such as electricity generation, oil and gas wells and pipelines and coal mines. If other sectors such as water and telecommunications are included, then planned expenditure rises to some US$100 billion a year for the next five years and probably for several years thereafter. Much of this is, of course, provided from domestic sources but as much as US$50 billion a year could be looked for from foreign sources.
Fortunately for China, many sources of finance are open to it. China is one of very few countries which is both very poor and judged to be a reasonable credit risk. (The low standard of living is measured by GDP per head, which is around US$600 - calculation on a purchasing power parity basis would increase this figure dramatically to US$2,000 or more). This dual qualification allows China to access the range of international capital markets on the one hand, and on the other hand to attract loans and grants from national and multilateral sources. As far as international banks are concerned, Chinese institutions are seen as responsible borrowers provided the rules are obeyed. It was not ever so. There was a period in the mid-1980s when the Chinese economy was expanding very fast and the number of institutions borrowing or acting as guarantors in the international loan market was also rapidly expanding. Following some advice from senior international bankers the Chinese authorities cut back very sharply on the numbers of institutions that were allowed to participate in the international market, and created a limited number of so- called 'windows' through which transactions with the international banking market could be carried on. More recently, the number of windows has been increased but a relatively tight control is still maintained on overseas borrowing. This has meant new borrowing of between US$15 and US$20 billion a year net.
Total foreign debt is now around US$150 billion but foreign currency reserves are reported to stand at $140 billion, which gives a very respectable net figure. This, and the robust situation of Chinese exports, gives lending banks a lot of comfort and also, of course, justifies the fact that national Export Credit Agencies are prepared to grant very large credit limits for China. In addition, China is a large borrower from the World Bank and the Asian Development Bank. There is in fact some discussion now about whether China is too big a borrower from these institutions, given that it is a credit worthy country and may be crowding out borrowers who would find it more difficult to access the market.
How about other sources of finance for China; presumably they do not want to rely exclusively on borrowing?
There are a number of other sources, as I indicated earlier. Perhaps the next choice to bank borrowing is the bond issue. China and its State banks have become major issuers of a range of bonds in a range of currencies. These have taken in floating rate notes and fixed interest issues with tenors ranging from one to one hundred years. The amounts are large as well, with bond sizes up to $1 billion or more.
China is also making full use of the international equity market, with a number of companies being allowed to issue shares in foreign markets. The market that has been accessed most often has been Hong Kong, which has seen a large number of so-called 'H Share' issues. There have also been equity issues in New York and Sydney but London was not allowed until a Memorandum of Understanding was signed between the British and Chinese governments in October last year. The first quarter of this year saw the first introduction of a Chinese company's ordinary shares to the London stock exchange when we acted as sponsor to Beijing Datang Power Generation Ltd, a company which generates electricity for the Beijing and Tianjin districts in North China. The issue was extremely successful, raising some $600 million, and the shares now stand at a premium of some 40% to the issue price. The formula that proved so attractive was the linking of a quotation in London with a quotation in Hong Kong, bringing in both the big institutional investors and a significant retail interest. A number of other Chinese companies have subsequently shown considerable interest in coming to London.
There is also a large amount of direct investment from abroad, not using the stock market. As you know a considerable number of ethnic Chinese live outside China, many of them in other Asian countries, and these people have accumulated considerable wealth. This is the major source of direct investment back into China, with Hong Kong and Taiwan leading the way. There is also, of course, direct investment by foreign companies as well coming from a wide variety of countries. Korea is important, as are Japan and the United States with the United Kingdom being by far the largest European investor. These foreign direct investment figures have been very substantial, especially in comparison with what goes to other countries. In a peak year it has reached almost US$40 billion, with the current figure still running at US$30 billion or so. This compares with US$2 billion for India for example in 1995, which was a record year.
One subdivision of this direct investment is the growing number of so- called 'private equity' funds, sometimes called venture capital or development capital funds, which have put money into joint ventures or other unquoted investments in China. We manage one of these funds called The China Investment & Development Fund. This has a net asset value of around $80 million and is invested in 10 joint ventures in China. It has not been easy, even with the economy growing at 9 per cent or more each year, but the long-term promise is still there.
You have painted a fairly rosy picture. What do you see as the problem areas?
I think there is one very serious problem when dealing with China and this is the lack of a developed legal system. It does make life very difficult in a number of ways. There is also a situation at the minute where we are told that a number of sets of regulations are about to be produced, but they are taking a long time to appear. This may indicate uncertainty over policy or it may indicate conflict between different organisations. There are, for example, no adequate regulations covering the establishment of domestic investment funds, clearly essential if the stock market is to be developed and become less volatile. The finalisation of these regulations, whether they involve foreign joint ventures or not, is clearly an important priority. Another area is the lack of clear guidance to potential investors in projects on a Build Own Operate, and possibly Transfer, basis. A number of projects which are in fields which are important to China, such as power generation, have not gone ahead because of protracted arguments over the rate of return which a foreign investor can be allowed to earn. This is a problem for China as the projects are not being built and the potential investors are looking elsewhere - to India, Indonesia and the Philippines, for example.
I detect slightly more order in the stock market as the China Securities Regulatory Commission flexes its muscles, but corporate governance is still virtually non-existent and much needs doing in this area. The managers of companies have got to be held responsible for their actions, which very frequently are entirely contrary to the best interests of their shareholders.
There have been questions about the Chinese banks. Do you see a crisis in this area?
There are undoubtedly very severe problems within the banking system and the lack of profitability of many large State companies does not help, but I think that the overall situation is improving, albeit slowly. The creation of the three new 'policy' banks three years ago has certainly assisted the shift to a more commercially oriented regime for the existing large banks. This is particularly true of the State Development Bank, which was created to take on the major new projects such as the massive Three Gorges Hydro-electric Scheme. The existing banks are now supposed only to lend money for commercial reasons, but what can they do with a large State industry enterprise which is losing money? The alternative of bankruptcy involves a big political decision, and there is enough of a problem of uneven growth in various areas already without unemployment resulting from a rapid run-down of heavy industry in the North-East of the country.
There are some interesting second tier banks, such as Bank of Communications and CITIC Industrial Bank, which have always been run on more commercial lines and are growing fast. There are even some new banks being created which are regarded as being in the private sector, such as the Mingsheng Bank. All of these developments are assisting with the transformation to a more efficient and competitive banking system.
As you can tell from my comments, I realise that China still has considerable problems but it also has tremendous strengths and I am sure that it will assume more and more importance in the commercial world over the next twenty years. I look forward to witnessing its further evolution. It focuses the mind to consider that by 2020 China is likely to be once again the largest economy in the world after a gap of only 200 years!